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Armenian Government introduces drastic changes to the pension system

June 28, 2010

In 2014, Armenia will entirely switch to an accumulated pension system. Last week, the bill on “State Pensions”, which comprises of pension reforms, was discussed and passed with first reading at the special session of the National Assembly. According to the draft bill, in 2011 the voluntary option of the accumulated pension system would come into force, with the compulsory one starting three years later.

Pensioners protest outside the main government building in Yerevan, undated.

Ara Khanjian

The government of Armenia is proposing radical changes in the pension system. The proposed changes are extreme because 100% of employee pension contributions will be allocated in private individual pension accounts, which will be invested in stock and bond markets. After a transition period of about 25 years, every employee will be part of this extreme pension model. Out of about two hundred countries in the world only a few countries, mainly Chile, Kazakhstan and Kosovo, have such an extreme system.

A private pension system has many risks and problems such as financial market risk, labor market risk, an increase in government deficit until current retirees pass away, high cost of managing private pension accounts, etc. Financial market risks of private pension systems are significant. In a private pension accounts, the pension benefits that a retiree would receive would depend on the timing of his/her retirement. If the employee retires after few bad years in the financial markets, the retirement benefits would replace only small part of his/her pre-retirement income and he/she could live in poverty.

The world financial crisis of the past two years emphasized the financial market risk of the private pension system. Argentina had a mix, private and public, pension system. However because of the recent financial market crisis, during November 2008 it eliminated the private aspect of the pension system and once again adopted a 100% state owned pension system. It is surprising that while the world is still recovering from the recent financial market crisis, Armenia’s government is proposing a pension system where 100% of the employees’ pension contributions will be put in financial markets through private pension accounts.

Another problem of the government’s proposal is that a pension system based on private accounts requires developed and transparent financial markets and institutions, competent managers and efficient regulations and regulators. Unfortunately, in the case of Armenia, all of these are lacking and at the same time there is a significant amount of corruption, which makes the adoption of a private pension system riskier. During October 2008, even the IMF and the World Bank experts advised the government to “reformulate” the pension changes proposed by the government in order “to reduce risk and improve sustainability.” The main characteristics of the current government pension proposal are similar to the proposal presented during 2008.

The private pension system could increase the savings of the individuals; however its effect on the savings and investment of the whole country is questionable, because the adoption of the private pension system would reduce government savings, through larger government budget deficits. This implies that the reduction of government savings would offset the potential increase of individuals’ savings and the final effect of private pension system on national savings and investment would be uncertain. However, most economists would agree that the ultimate determinant of a desirable pension system should be the well being of the retirees and not some other goal or determinant, such as the national savings rate or the development of domestic financial markets.

Armenia, similar to many countries in the world, is facing the problem of an aging population, which could increase the cost of maintaining a pension system. Therefore it is important for us Armenians to discuss and figure out the best pension system that would deal with future demographic problems and which at the same is fair and sustainable. There are many possible alternatives, such as national or public, private, mix private and notional, etc., pension systems to the existing pension model.

Finally, in many Western countries, such as Sweden and the U.S., a political party with a majority of the seats in the parliament avoids imposing its will on the country and adopting radical changes in the pension system because in few years another political party could acquire a majority of seats in the parliament and it could introduce another radical change in the pension system. Pension reforms affect every citizen of the country and changes are costly; therefore they should be adopted through significant amount of national debate and if possible, a consensus.

The whole country should discuss and debate different options, such as public, private and mix pension systems. A non-political, professional state agency, such as the National Statistical Service, should initiate simulations and actuarial analysis of different pension options and present the results to the parliament and the public for debate. Only then Armenia should adopt a new pension system.

(Ara Khanjian is a Professor of Economics at Ventura College, California)